[...]... regardless of the dollar/DM movement; • Was able to eliminate currency risk for the Germany supplier Bae 9 Currency Futures versus Currency Options Currency Futures Obligation to buy/sell FC No premium payable Only one forward rate for a particular delivery date Fixed delivery date of currency Eliminates upside potential & downside risk Currency Options Right to buy/sell FC Premium payable Wide range... known, buy currency forward; when unknown, buy a currency call option When the quantity of a FC cash inflow is known, sell currency forward; when unknown, buy a currency put option When quantity of a FC cash flow is partially known and partially uncertain, use a forward to hedge the known portion and a currency option to hedge the maximum value of the uncertain remainder Bae 13 Case Study: Using Currency. .. 11 Usefulness of Currency Options Currency options are especially useful when: FC cash flows are contingent that cannot be hedged with forward contracts Ø Example) acceptance of a bid The quantity of FC to be received or paid out is uncertain Ø Uncertain FC accounts receivables Ø Uncertain FC accounts payables General Rules General Rules on Using Currency Options versus Currency Futures When the quantity... Currency Options to Hedge FX Risk of Uncertain Payables (1/3) Cadbury Schweppes Company: Type: corporation British (CS) multinational Major Products: soft drink (55%) and candy (45%) Employees: 39,066 Annual Sales: $5,730,000,000 Operations: Markets in more than 170 countries Britain (43%); Erope (20%); North America (17%); Asia (14%) Case Study: Using Currency Options to Hedge FX Risk of Uncertain Payables... eliminate the currency element in the decision to purchase the commodity, thus leaving the company’s purchasing managers able to concentrate on fundamentals This task is complicated by the fact that the company’s projections of its future purchases is highly uncertain Bae 15 Case Study: Using Currency Options to Hedge FX Risk of Uncertain Payables (3/3) Strategy/Action: CS has turned to currency options... establish costs and revenues in local currency Case Study: Using Currency Options as a Competitive Tool (3/7) Strategy/Action: AS bought from its bank a multiple option facility: a two-year American-style call option on the dollar, with puts against each of the four non-dollar currencies-deutsche marks, French francs, Finnish markka, or Norwegian kroner => Through this option contract, the Scandinavian... as an insurance policy Case Study: Using Currency Options as a Competitive Tool (1/7) Allied Signal, Company: Inc (AS) Type: N.J.-based U.S multinational corporation Major Products: aerospace (38%), automotive (38%), engineered materials (24%) Employees: 86,400 Annual $11,827,000,000 Sales: Operations: U.S (78%); Europe (16%); Canada (2%) Bae 17 Case Study: Using Currency Options as a Competitive Situation:...Hedging w/ Currency Futures Now Later Net Position Now Later Net position Cash Market Position Short Long => BUY Profit/Loss Long Short => SELL Profit/Loss Futures Market Position Long => BUY Short => SELL Loss/Profit Short => SELL Long => BUY Loss/Profit Case Study: Using Forward Prices to Reduce Capital Costs (1/5) Hewlett Packard Company:... Study: Using Forward Prices to Reduce Capital Costs (3/5) Sales and Capital Budget of Microwave Technology Division, HP 1990 1992 Annual Sales $15,000,000 $23,000,000 Capital Budget $10,000,000 $22,000,000 (equipment only) ($2,500,000) ($7,500,000) Foreign Sources of Equipment Purchases by MT Division Country Amount Percentage (%) Japan $4,500,000 60.0 Germany 1,200,000 16.0 Austria 1,000,000 13.3 England... 96,200 Annual Sales: $28,000,000 from 65 countries Sales distribution: US (50.1%), Europe (28.7%), Asia, Canada, and Latin America (21.2%) Bae 5 Case Study: Using Forward Prices to Reduce Capital Costs (2/5) HP Microwave Leybold Technology Division Technologies Co Buys from a German company and has to pay in DM Sell a thin film deposition system Quoted Prices in Purchasing Contract: •German DM: DM1,314,720 . International Management Conference Global Risk Management Hyatt Regency, Cleveland, OH 17-18 April 2002 Managing Global Financial Risk Using Currency Futures and Currency Options Sung C. Bae Ashel. University Corporate Risk Management Corporate Risk Financial Derivatives Commodity Risk · Risk associated with movement in commodity prices · Operational risk Interest Rate Risk · Risk associated. the dollar/DM movement;. • Was able to eliminate currency risk for the Germany supplier. Bae 9 Currency Futures versus Currency Options Currency Futures Obligation to buy/sell FC No premium payable